FDIC sues former top WaMu executives

By AUBREY COHEN, SEATTLEPI.COM STAFF

Published 10:00 pm, Wednesday, March 16, 2011

The Federal Deposit Insurance Corp. on Wednesday sued three former top executives of Washington Mutual, accusing them of taking "extreme and historically unprecedented risks" with the failed bank's home loan portfolio.

The suit names former WaMu Chief Executive Officer Kerry Killinger, Chief Operating Officer Stephen Rotella, WaMu Home Loans President David Schneider, and Killinger and Rotella's wives, alleging they piled on the risk to boost their personal wealth.

"They focused on short term gains to increase their own compensation, with reckless disregard for WaMu's longer term safety and soundness," the FDIC wrote. "Their negligence, gross negligence and breaches of fiduciary duty caused WaMu to lose billions of dollars."

The FDIC said it brought the suit "to hold these three highly paid senior executives, who were chiefly responsible for WaMu's higher risk home lending program, accountable for the resulting losses."

WaMu amassed more than $100 billion in loans and suffered billions in losses once the real-estate bubble burst. The Office of Thrift Supervision closed WaMu on Sept. 25, 2008, making it the largest bank to fail in U.S. history.

In particular, the suit alleges gross negligence, negligence, breach of fiduciary duty and fraudulent conveyance. It says WaMu recklessly made billions of dollars in risky house loans "knowing that the real estate market was in a "bubble" that could not support such a risky strategy over the long term, that WaMu did not have the technology to adequately manage and evaluate the higher risks associated with the portfolio, and in the face of continuing warnings from WaMu's internal risk managers.

"This relentless push for growth was exemplified by WaMu's advertising slogan, 'The Power of Yes,' which promised that few borrowers would be turned away."

Risky loan options included adjustable-rate mortgages, where borrowers started with artificially low "teaser" rates that then jumped to levels they couldn't afford; home-equity lines of credit piled on top of first mortgages as home prices bubbled, taking away any equity; and subprime mortgages to borrowers with poor credit scores and bad credit histories, according to the lawsuit.

WaMu approved many of these loans with little or no documentation of income or assets, and to speculators and second-home buyers with little invested in the homes, it says, adding that the bank bought up similarly risky loans originated by third-parties without proper review.

"Defendants knowingly pushed their Higher Risk Lending Strategy at a point in the housing cycle when prices were unsustainably high," the lawsuit says. "WaMu focused its growth in a few geographic areas -- notably California and Florida -- where housing prices had escalated most rapidly and were most at risk for significant decline.

"Defendants thus gambled billions of dollars of WaMu's money on the prospect that the Bank somehow would manage to avoid losses on higher risk loans to high-risk borrowers in high-risk areas, despite their own awareness of the inevitable decline in the overheated housing market."

And they knew that WaMu " had a woefully inadequate infrastructure -- including technology, controls, and data quality -- to support the high volume of risky loans," the suit says. "The Bank could not adequately track and analyze its loans, measure or price for its risks, or timely adjust to changes in the market.

"Rotella acknowledged in testimony before the United States Senate that WaMu's 'technology was antiquated,' and that the Bank 'was on an explosive growth path with a very weak infrastructure.' Schneider similarly admitted to WaMu's Board in June 2008 that one of his and the Bank's 'misses' was '(m)arket share and growth focus at the expense of building solid infrastructure and controls.'"

During this, "Killinger, Rotella and Schneider marginalized the risk management function in WaMu's Home Loans Division," the suit says. "Repeated warnings about the risks associated with the Bank's aggressive lending practices -- even those as stark as senior risk managers declaring that WaMu was 'putting borrowers into homes that they simply cannot afford' -- went unheeded. As the Bank's chief risk officer told Killinger just weeks before WaMu went into receivership, the Bank's 'DNA' was missing 'the risk chromosome.'"

So why did they do this?

According to the lawsuit, "their fixation on short-term profits fueled a myopic focus on growing the ... residential mortgage portfolio, which rewarded them for the Bank's short-term gains. During the period from January 2005 to September 2008, Defendants collectively received more than $95 million in compensation. As the losses mounted in the Spring and Summer of 2008, Killinger and Rotella recognized the potential problems and took steps to move at least part of their wealth beyond the reach of their creditors."

Responding to The Wall Street Journal, Killinger called the lawsuit "baseless and unworthy of the government," adding: "The factual allegations are fiction."

Rotella told The Journal: "it is almost beyond belief that the FDIC would take action against an effective, hard working bank manager who performed well under extraordinary conditions in an effort to save an important financial institution," saying the FDIC's investigation "lacks credibility and is unfair, since it has flatly refused Mr. Rotella's offer to meet, answer their questions, and explain his role as Chief Operating Officer at the company. Furthermore, it is patently unfair for the FDIC to expect an individual to have perfect foresight into a crisis that the FDIC itself did not see coming."